Trouble for Equities But With a Chance of Sunshine

Before yesterday’s sell off, which was the first 1% decline in the S&P 500 since late-July, a form of consolidation had been taking place in the major indices while things began to fall apart below the surface.

First up I want to look at the relationship between consumer discretionary and consumer staples. Typically when discretionary stocks outperform staples it’s a sign that traders are comfortable in a ‘risk on’ rally. But when this relationship breaks down and staples begin to outperform, which has they have been the case for over a week now, a warning flag goes u as traders shift into the lower beta names.

We are seeing the same type of breakdown when comparing the relative weekly performance of the Nasdaq Composite to 30-year Treasury bonds. I’ve marked with  dotted red lines each time since 2006 this relationship has fallen below 22, which historically hasn’t lead to happier days for equities prices. However, we did see a whipsaw in 2011 before substantial declines in the S&P took place, so this doesn’t necessary mean we drop like a rock just because of this weakness.

There are still some technical components that give us some hope for a continued advance. First, we have to remember this is how the market initial responded to the QE 2 announcement back in November 2010, a 40 point dip before bulls take back the reins to finish the year on a positive note. Also I’m noticing momentum, based on the McClellan Osc. appears to have entered oversold territory on a very short-term basis based on certain metrics.

So while it seems traders are taking risk off the table with the outperformance in the lower-beta consumer staples space and 30-year Treasury’s, the current price action in equities doesn’t seem to be out of the ordinary when it comes to QE announcements. It still seems that 1430 is the level to watch on the downside, if we get to that point.